Process of Accounting08/01/2022 0 By indiafreenotes
The word “Accounting” brings along with itself thousands of years of history and can be traced back to ancient times. There are proofs which suggest that accounting might be more than 7000 years old. Now, let’s just quickly get back to modern times and try to understand what really accounting and the accounting process is all about.
- Identifying and Analyzing Business Transactions
The accounting process starts with identifying and analyzing business transactions and events. Not all transactions and events are entered into the accounting system. Only those that pertain to the business entity are recorded.
Business transactions identified are then analyzed to determine the accounts affected and the amounts to be recorded.
Also, this step involves the preparation or collection of business documents, or as auditors would call them source documents. A business document serves as basis for recording a transaction.
- Recording in the Journal
A journal is a book–paper or electronic in which transactions are recorded. Journals are also known as Books of Original Entry.
Business transactions are usually recorded using the double-entry bookkeeping system. They are recorded in journal entries under at least two accounts (at least one debited and at least one credited). Transactions are recorded in chronological order and as they occur.
- Posting to the Ledger
Also known as Books of Final Entry, the ledger is a collection of accounts that shows the changes made to each account as a result of past transactions recorded. It also shows their current balances.
For example, all journal entry records under the “Cash” are posted into the Cash account in the ledger. We will be able to calculate the increases and decreases in cash; and from that, we can determine the ending balance of the Cash account.
- Preparing the Unadjusted Trial Balance
A trial balance is prepared to test the equality of the debits and credits. All account balances are extracted from the ledger and arranged in one report. Afterwards, all debit balances are added. All credit balances are also added. Total debits should be equal to total credits.
When errors are discovered, correcting entries are made to rectify them or reverse their effect. Take note however that the purpose of a trial balance is only test the equality of total debits and total credits and not to determine the correctness of accounting records.
Some errors could exist even if debits are equal to credits, such as double posting or failure to record a transaction.
- Adjusting Entries
Adjusting entries are prepared as an application of the accrual basis of accounting. At the end of the accounting period, some expenses may have been incurred but not yet recorded in the journals. Some income may have been earned but not entered in the books.
Adjusting entries are prepared to update the accounts before they are summarized in the financial statements.
Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income method or liability method), prepayments (asset method or expense method), depreciation, and allowances.
- Adjusted Trial Balance
An adjusted trial balance may be prepared after adjusting entries are made and before the financial statements are prepared. This is to test if the debits are equal to credits after adjusting entries are made.
- Financial Statements
When the accounts are already up-to-date and equality between the debits and credits have been tested, the financial statements can now be prepared. The financial statements are the end-products of an accounting system.
A complete set of financial statements is made up of: (1) Statement of Comprehensive Income (Income Statement and Other Comprehensive Income), (2) Statement of Changes in Equity, (3) Statement of Financial Position or Balance Sheet, (4) Statement of Cash Flows, and (5) Notes to Financial Statements.
- Closing Entries
Temporary or nominal accounts, i.e. income statement accounts, are closed to prepare the system for the next accounting period. Temporary accounts include income, expense, and withdrawal accounts. These items are measured periodically, hence need to be closed to have a “fresh slate” for the next accounting period.
The accounts are closed to a summary account (usually, Income Summary) and then closed further to the capital account. Again, take note that closing entries are made only for temporary accounts. Real or permanent accounts, i.e. balance sheet accounts, are not closed.
- Post-Closing Trial Balance
In the accounting cycle, the last step is to prepare a post-closing trial balance. It is prepared to test the equality of debits and credits after closing entries are made. Since temporary accounts are already closed at this point, the post-closing trial balance contains real accounts only.
|Collecting and Analyzing Accounting Documents
|It is a very important step in which you examine the source documents and analyze them. For example, cash, bank, sales, and purchase related documents. This is a continuous process throughout the accounting period.
|Posting in Journal
|On the basis of the above documents, you pass journal entries using double entry system in which debit and credit balance remains equal. This process is repeated throughout the accounting period.
|Posting in Ledger Accounts
|Debit and credit balance of all the above accounts affected through journal entries are posted in ledger accounts. A ledger is simply a collection of all accounts. Usually, this is also a continuous process for the whole accounting period.
|Preparation of Trial Balance
|As the name suggests, trial balance is a summary of all the balances of ledger accounts irrespective of whether they carry debit balance or credit balance. Since we follow double entry system of accounts, the total of all the debit and credit balance as appeared in trial balance remains equal. Usually, you need to prepare trial balance at the end of the said accounting period.
|Posting of Adjustment Entries
|In this step, the adjustment entries are first passed through the journal, followed by posting in ledger accounts, and finally in the trial balance. Since in most of the cases, we used accrual basis of accounting to find out the correct value of revenue, expenses, assets and liabilities accounts, we need to do these adjustment entries. This process is performed at the end of each accounting period.
|Adjusted Trial Balance
|Taking into account the above adjustment entries, we create adjusted trial balance. Adjusted trial balance is a platform to prepare the financial statements of a company.
|Preparation of Financial Statements
|Financial statements are the set of statements like Income and Expenditure Account or Trading and Profit & Loss Account, Cash Flow Statement, Fund Flow Statement, Balance Sheet or Statement of Affairs Account. With the help of trial balance, we put all the information into financial statements. Financial statements clearly show the financial health of a firm by depicting its profits or losses.
|All the different accounts of revenue and expenditure of the firm are transferred to the Trading and Profit & Loss account. With the result of these entries, the balance of all the accounts of income and expenditure accounts come to NIL. The net balance of these entries represents the profit or loss of the company, which is finally transferred to the owner’s equity or capital.
|Post-Closing Trial Balance
|Post-closing Trial Balance represents the balances of Asset, Liabilities & Capital account. These balances are transferred to next financial year as an opening balance.
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